The Pitfalls of Protectionism

U.S. President Donald Trump gave voice to his plans within minutes of being sworn into office in January 2017: “From this day forward, it’s going to be only America first, America first.” The president is sending a clear signal that he is a protectionist. In simple terms this means putting taxes, called tariffs, on goods and services entering the United States. He has tossed around the figure of 35 percent. The idea is that the tariff makes foreign products more expensive than domestic ones. As a result, consumers buy domestic goods thereby boosting manufacturing and jobs.

There is nothing new about this. Throughout its history the U.S. has gone through periods of protectionism.

It's 1910 and the United States and others try to sell the prosperity promised by protectionism. | Source

Protectionism in the 1930s

The best-known protectionist measure was the Smoot-Hawley Tariff of 1930. The Stock Market Crash of 1929 had plunged the world into a recession that was to linger for a decade and earn itself the unenviable title of the Great Depression.

Two U.S. Congressmen, Reed Smoot and Willis Hawley, sponsored a bill they believed would put Americans back to work. It grew out of a plan to help American farmers who were going through a rough spell.

Willis Hawley (left) and Reed Smoot. | Source

Tariffs were increased on more than 900 import duties affecting over 20,000 imported goods. The Economist reports that “More than a thousand economists petitioned [then-President Herbert] Hoover not to sign the Smoot-Hawley bill.” They believed that as the U.S. economy was already sputtering adding taxes to imports would only make matters worse.

They had five main points:

Goods would cost more thereby raising the cost of living;

Farmers would not be helped because their products were sold at world prices but the cost of farm machinery would rise;

“Our export trade in general would suffer. Countries cannot buy from us unless they are permitted to sell to us;”

Other countries would retaliate with tariffs against American goods; and,

Americans with investment overseas would suffer because a tariff would make it harder for “foreign debtors to pay them interest due them.”

But, Hoover did not listen to the number crunchers and signed the bill into law. It was a terrible decision. For once, the economists got it right.

Trade Collapsed

The effect of the Smoot-Hawley Tariff was felt almost immediately, and not in a good way.

The Washington International Trade Association notes that two years after the Smoot-Hawley Tariff became law “unemployment had reached almost 24 percent in the U.S., more than 5,000 banks had failed, and hundreds of thousands were homeless and living in shanty towns called ‘Hoovervilles.’ ”

Some analyses say that by the time some form of stability returned the number of bank failures totalled 10,000. And, of course, a collapsing bank takes all its depositors money with it.

The Foundation for Economic Education adds that “From 1929 to 1933 America suffered the worst economic decline in its history. Real national income fell by 36 percent …”

A Hooverville. | Source

The Contagion Spread

Other nations put up protectionist tariffs to counter those of the U.S. These tariff walls had the effect of suffocating an international trading system already struggling for breath.

The economic collapse travelled around the world and few countries were hit harder than Canada, America’s largest trading partner. The Waterloo Record reports that “The price of lumber fell 32 percent from 1929 to 1932, and cattle prices declined 63 percent. Smoot-Hawley sent major Canadian pulp and paper companies into bankruptcy. Canadian automakers saw their exports collapse to 13,000 vehicles in 1931 from 102,000 in 1929. Manufacturing, in general, declined more than 50 percent.

“Unemployment reached an average of 32 percent in Canadian cities. In Windsor, Ont., it reached 50 percent. In the Maritime provinces, unemployment for ordinary labourers hit 60 percent.”

In 1935 unemployed Canadians started the On-To-Ottawa trek to protest their poor treatment. They were stopped before they got to the capital. | Source

Of course, the United States, the architect of the debacle, suffered as well. Mining states were hard hit because other countries raised tariffs against U.S. mineral exports. Steel exports took a major hit such that in September 1931, 11 of Pittsburgh’s biggest banks closed their doors. Same story in Detroit where plunging auto sales triggered bank failures.

Correcting the Error of Smoot-Hawley

By 1933, it was recognized the Smoot-Hawley Tariff had been a terrible mistake. In March 1934, the Reciprocal Trade Agreements Act became law giving President Franklin D. Roosevelt the power to alter tariff rates. He set about negotiating trade agreements with other countries and cutting tariffs.

But the Smoot-Hawley blunder had put the world’s economy in such a deep hole that it would take years to climb out. It wasn’t until 1947, when the General Agreement on Tariffs and Trade (GATT) was signed, that the era of freer trade truly opened up.

The GATT and its successor the World Trade Organization (WTO) have presided over almost 70 years of relatively calm international commerce. Under the GATT/WTO regime, average tariffs have dropped from 40 percent to six percent. The value of world trade is now 29 times higher than it was in 1950. WTO agreements cover 98 percent of the world’s population and the claim is made that the open trading system has helped lift more than one billion people out of extreme poverty.

To be sure, free trade creates winners and losers, but the consensus among experts is that such a system is vastly better than protectionism. This is why so many people get twitchy when President Trump starts channelling the ghosts of Reed Smoot and Willis Hawley.

The Economist Does not Like Protectionism

Bonus Factoids

Some suggest the Smoot-Hawley Tariff even caused the Stock Market Crash of October 1929. The argument is that savvy investors picked up signals that tariffs were coming in late 1928 and got out of the market leaving less well-informed players to take the hit.

Many political scientists have argued that the economic chaos of the 1930s made it easier for Adolf Hitler to rise to power. And, we all know how that turned out.

Source

In his inaugural address Mr. Trump urged people to “buy American and hire American.” According to Reuters, the Trump campaign had its “Make America Great Again” caps made in China, Vietnam, and Bangladesh.

“Those who cannot remember the past are condemned to repeat it.” George Santayana.

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